Point and figure charting

Point and figure charting is thought to have been devised by Charles Dow, founder of the eponymous stockmarket index. It is a distinctive method, quite unlike any other form of graphing price movements.

Most high-end investment software packages - Updata's Trader system is a good example - are configured with point and figure charts as one of their options.

It is essential at the outside to get a few things straight about this method of technical analysis.

The first is that movements in the chart are only recorded if they exceed a certain arbitrarily chosen amount. This is known as the 'box size'. In a share price chart this could be ½ p, 1p, 2p, 5p, 10p or any other amount depending on the absolute level of the share price. Let's take a share with a price of 500p. The box size in this case might be, for example, 5p. If the share moves up from 500p to 510p, then two boxes are recorded, in the case of an upward movement in the share, by an 'x' in the chart.

Let's say the share then moves up by a further 5p, a further 'x' is marked on the chart, immediately above the other two. If the share then moves down to 495p, a new column is started and the drop of 20p recorded by filling in four vertical boxes, each with an 'o' to record a downward movement. If the share then recovers to 505p, then a new column is started and two 'x' boxes filled in.

After these movements, the chart would look something like this:

x

xo

xox

xox

o

As the share price progresses up and down, so new columns are started. Movements of less than the box size (in this case 5p) are ignored. Only when the price breaches a 5p cumulative change over a few days would a new box be filled in. A chart like this would be known as a five-point reversal.

It's also important to remember that there is no regular scale reflecting the passage of time on a chart like this. The chart progresses rightwards from the vertical axis based solely on the speed with which new columns are created on the chart as a result of changes in direction (of, in this case, 5p or more) in the chart. The more changes in direction, the more sideways movement there is. The passage of each month is noted simply by a recording a figure (1 for January, 2 for February, and so on) in the appropriate box on the occasion of the first price change after the start of a new month. Hence the term 'point and figure'.

Point and figure charts often look slightly odd. In the example above, for instance, if the share subsequently dropped to 445p and then consolidated around that level, the chart would look like this.

x

xo

xox

xoxo

o o

o

o

o

o

o

ox x

oxoxoxx

oxoxoo

oxo

o

It is from movements like this, that point and figure chartists infer patterns that might suggest possible future price action.

Often the breadth of a particular formation can provide an indication of the likely strength and duration of a subsequent change in the long term trend. In other words, patterns that indicate a coming reversal may be deemed particularly significant if they are formed from a large number of subsidiary movements.

Chart patterns are important in point and figure.

Because it is the frequency of changes in trend, and their size, that determines the shape of the chart - with the passage of time removed from the equation - P&F charts often form distinctive patterns that show up with greater clarity than they do on conventional charts. Technical analysts give these patterns distinctive names - 'flags', 'pennants', 'head and shoulders', 'fulcrum points', 'saucer bottoms' and so on. These are merely evocative shorthand for price action that might presage particularly significant chart movements, up or down.

The normal panoply of charting concepts - uptrends, downtrends, breakouts and so on - also apply. But the trading volume accompanying particular price movements plays no part in point and figure chart analysis.

Most point and figure charts are constructed on an arithmetic scale, but a logarithmic scale can be used, in which case the box size is a percentage amount rather than an absolute one.

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